Market Snapshot: PPA Investor Growing Pains
We’ve been tracking acceleration in solar’s middle market since the passage of the Inflation Reduction Act. Rather than an immediate burst, this growth has come gradually as policies have been clarified and implemented. We noted how this momentum was stretching the existing capacity of developers and investors last fall. These challenges have compounded through the first part of 2024. We’re taking a moment here to share our insights on where the market is, where things are headed, and what it means for developers and EPCs.
US middle market picking up steam
The biggest factor driving market acceleration so far is the gradual clarification of investment tax credit adders by the IRS. We’ve provided updates on IRS guidance before. Here we’ll focus on the three primary adders impacting PPA project pricing:
Energy Communities. The clearest and most reliable adder so far, energy communities are well understood by the market and routinely priced into financing. The key wrinkle is that some of these qualifying territories can change, so developers and investors may need to ensure that projects start construction in the right year for qualification.
Low to Moderate Income. LMI bonus credits are great, if awarded. But they are limited in quantity and about 10x oversubscribed in most categories. So qualification doesn’t mean much until the project award is received.
Domestic Content. This one has been a sleeper so far. Equipment manufacturer reticence to open their books is understandable, but it has kept most of the market from incorporating the DC adder. We don’t expect it to become a regular part of project pricing until at least 2025, maybe 2026.
A new source of momentum this year is the EPA’s $27B Greenhouse Gas Reduction Fund. With the recent announcement of $20B in awards, we expect funds from this program to start flowing into the market in the 2nd half of 2024.
The upshot of these gradual rollouts of federal incentives is steadily building momentum and a steadily growing volume of viable projects. While great news for the industry, this does create growing pains for the companies working to deliver these projects.
The squeeze on investor bandwidth
The limits on investor capacity that we noted in the fall have come back with a vengeance. We’ve seen this show up in a number of ways recently, including:
Significant hiring, particularly for investor sales reps and the build-out of origination teams to support the increased project activity.
Tightening criteria. Investors are focusing on a narrower set of project types and being more selective as to what’s a “Grade A Project” for them. The low end of an investor’s target project size has tended to creep higher.
Slower response times. More investors have struggled to hit their bid deadlines or taken more time to follow up on diligence reviews.
Investors mentioning how busy they are. We are hearing this more consistently and from more parties than normal.
What this means for project financing
With a broad view, these trends are understandable. But for an individual project, the experience is bewildering. Investors that used to be a fit and a reliable partner may no longer be interested, or may require more vigilance to keep their attention. Things can change mid stream, and rapidly. We’ve even seen investor origination teams caught off-guard by shifts at their own companies.
In this context, it’s important to remember that the fit between a project and an investor has several dimensions, including:
Competitive pricing and deal terms
Ability to execute and close deals on the terms initially proposed
Speed to close and responsiveness throughout the process
Developers and EPCs may encounter challenges at any point. And because they lack visibility into the inner workings of investment companies, it’s very difficult for them to see these changes coming. But the impact on their projects can be significant.
How developers and EPCs should respond
At the start, it’s important to get multiple offers from high quality investors. The right investor for the next project may be different than the last one. And you can’t really assess this without seeing an offer and comparing it to others in the market. Beyond ensuring a good fit and the best pricing, multiple offers also give developers and EPCs backup options in case something goes wrong. This is especially important when market shifts catch teams by surprise.
In bidding and diligence, developers and EPCs should pay close attention to responsiveness and follow-through. It’s reasonable to expect transactions to take a little longer. And some patience is important as investors work to staff up. But they still should be following through on deals in process.
Fortunately, we’re seeing great follow-through from our top investor partners, even if closing takes a week or two longer than in the past. When investors are willing to make an offer, they’ve typically shown an ability to transact on the project or portfolio.
Where this is all headed
Is this trend here to stay? Yes, very likely. The market is feeling the momentum of the IRA now, but it’s still gaining steam. As the Domestic Content adder and the Greenhouse Gas Reduction Funds really start flowing, we expect these trends to accelerate and exacerbate the current challenges.
It will take time to scale execution efficiency. Investors will be adding staff, new partnerships, and software solutions. Conductor will continue to advance our marketplace and our diligence tools to help investors become more efficient and more capable of handling larger and larger project volumes. The Conductor process starts with finding great partners and finishes with tools that help those partners transact and collaborate effectively all the way through to closing and construction.
